President Fujimori is serving an unprecendented third term

The protest follows the publication of a videotape in which Mr Montesinos, who is also a presidential adviser, appears to be bribing a congressman to defect to the government benches.

Demonstrators in Lima washed red and white Peruvian flags outside the presidential palace in protest against "dirty politics", and called for the resignation of President Alberto Fujimori.

The United States said it viewed the matter with the utmost gravity, and has called for an investigation into the allegations.

The BBC's South America correspondent, James Reynolds, says the videotape has dealt a severe blow to efforts by Mr Fujimori to improve his government's image following elections which were tainted by widespread allegations of fraud.

'Cancer of corruption'

Protesters have been washing the Peruvian flag every week since the elections, but the demonstrations acquired greater significance on Friday in the light of the videotape allegations.

The Peruvian public has a right to an expeditious, complete and transparent investigation that will reveal all the facts

US State Department

Luis Bambaren, the head of the Peruvian Bishops' Conference, added his voice to the protests, calling the scandal "shameful" and adding: "The cancer of corruption must be cut out."

The 58-minute videotape at the centre of the row, which was obtained by opposition congress members, was broadcast on a cable television channel on Thursday night.

It appears to show Mr Montesinos, the president's right-hand man, giving $15,000 in cash to Luis Alberto Kouri, a former member of the opposition Peru Posible party who recently defected to Mr Fujimori's Peru 2000 party.

Mr Kouri has denied that the money was a bribe, and says it was merely a loan to help him buy a truck for official business.

'Utmost gravity'

The US ambassador to Peru, John Hamilton, called on Mr Fujimori to take "clear and energetic" steps to correct the apparent crisis of confidence.

A State Department spokesman in Washington later described the scandal as "a matter of the utmost gravity".

The spokesman added: "The Peruvian public has a right to an expeditious, complete and transparent investigation that will reveal all the facts.

Alejandro Toledo is calling for the formation of transition government

"In light of these new developments we urge the government of Peru to take clear and dramatic steps to restore the public's confidence in the intelligence service while the investigation goes forward."

Peruvian opposition parties have said they are breaking off negotiations with the government on democratic reforms, and that continued talks are conditional on the arrest of Mr Montesinos.

The opposition and the government recently agreed on a timetable of reforms, including changes to the intelligence service, which were put forward by the Organisation of American States following Mr Fujimori's controversial re-election.

Another opposition leader, Alejandro Toledo, who pulled out of the election claiming that the vote was rigged, called for the immediate formation of a transition government and fresh elections to be held in a year's time.